There may have been a strong rally in equity markets in the first quarter of 2012, but the financial status of pension plans improved only slightly, according to Aon Hewitt.
According to the firm’s research based on a sample of pension plans, the median pension solvency funded ratio increased from 68% at the end of 2011 to only 69% as at March 31, 2012. About 97% of plans in the sample had a solvency deficiency as at that date.
The solvency funded ratio measures the financial health of a DB plan by comparing the amount of assets to total pension liabilities in the event of a plan termination.
The latest rating from Mercer’s Pension Health Index, released Monday, was even lower—standing at 63% on March 31—but up 3% from the end of the previous quarter.
According to Aon Hewitt, a typical pension fund earned an average return of 3.6% in this first quarter, made possible by good equity markets performance: 4.4% for the Canadian stock exchange, 10.5% for U.S. equities and 8.9% for international equities.
“The interest rates used in a March 31, 2012, solvency liability calculation are broadly comparable to the interest rates at the end of 2011,” said Thomas Ault, an associate partner and actuary with Aon Hewitt in Vancouver. “Interest rates are still at historically low levels, which means solvency liabilities remain very high.”
“The results of the first quarter underscore the importance of assessing DB pension plan performance in an asset-liability framework, as good asset performance was overshadowed by increased liabilities. By thinking about plan assets as either liability-hedging or return-seeking assets, plan sponsors can better manage the risk inherent in each component,” said André Choquet, an investment consultant and actuary with Aon Hewitt in Toronto.
“For example, pension plans typically invest in universe bonds, with terms of mainly between five and 10 years. Switching to long bonds, with maturities between 10 and 30 years will more closely match the plan’s liabilities cash flows and helps assets and liabilities behave in tandem when interest rates fluctuate.”
Aon Hewitt analyzed the performance of a plan de-risking through increased investment in bonds from 40% to 60% of a portfolio and investment in long bonds instead of universe bonds since the end of 2010. Such a plan would have experienced a 78% solvency ratio as at March 31, 2012, as opposed to 69% for a typical plan, says Aon Hewitt.